Why we shouldn’t be worrying about a house price bubble: ANZ’s Chronican

The great Australian dream – mum, dad and the kids in the house on the quarter-acre block – has been embedded in our national psyche since the fifties, when the world was booming after the double blow of the Great Depression and World War II.

Over the next few decades, paying down the mortgage was the ultimate goal. Once that was under control, it was time to consider buying an investment property as a way to prepare for the golden years, or as a means to boost the kids up a rung on the property ladder.

A lot has happened since then. We are now seeing rising levels of wealth, the size of households is changing, our population is growing and we are becoming much more culturally diverse as we welcome new groups of migrants into our communities.

And in the past five years we have witnessed significant upheaval across the world, resulting from the fallout from the global financial crisis.

We all know that Australia’s strong banking system and prudent regulation helped us to escape the brunt of the crisis.

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But increasingly we now hear that Australian house prices are overvalued, with concerns we will follow the United States and Europe into a housing market collapse.

Indeed, recent price rises in Sydney, Perth and Melbourne in particular have refreshed discussions about whether or not we are back inside a “housing bubble".

To understand why Australia avoided a correction in 2009 and 2010 and whether or not a crash is imminent, we need to understand that the US collapse was driven by a completely different set of circumstances.

Subprime mortgage crisis

The US “credit crunch" was triggered by the subprime mortgage crisis that ultimately led to the global financial crisis. While the causes of the GFC are being debated, it is clear that lax lending standards increased the vulnerability of the US mortgage market, which collapsed under the stress of higher interest rates and an excess of supply and lower home prices. This drove a sharp increase in mortgage defaults, particularly for variable-rate mortgages with negative housing equity.

In Australia, by comparison, mortgage loans are held on bank balance sheets rather than spun off into complex financial instruments, and typically feature lenders’ mortgage insurance, full recourse lending and stronger underwriting standards than seen in other markets.

Our banks withstood the freeze on credit markets that forced our European and US peers into the hands of their governments because we have typically adopted far more responsible and conservative lending standards.

And even though property prices spiked over the 15 years leading up to the GFC, we have seen no overhang of housing stock.

Robust migration levels and a considerable decline in housing construction activity since 2009 mean supply is actually lagging demand. Home building in Australia has remained largely stagnant over the past 30 years, with annual completions averaging around 145,000.

If we take 2005 as a starting point, the upturn in net overseas migration, combined with a lack of response from dwelling construction, has driven increasing pressure on housing stock availability.

ANZ estimates a shortfall of around 270,000 dwellings, equivalent to around 20 months of housing construction at current trend construction rates. Even if population growth stalled, it would still take almost two years to eliminate the current underlying housing shortage and return to the ratios observed in 2005.

Our current projections indicate this is likely to increase to a shortage of 370,000 dwellings by 2015 – around 30 months of housing construction.

Supply of new homes remains constrained by factors including rising building costs, loss of skilled construction workers to the mining states, lengthy approvals processes, tighter credit conditions, heightened aversion to debt, higher land prices, rising community objections and economic uncertainty, to name a few.

More action is required to address these concerns, particularly in NSW, where deteriorating rental availability and affordability continue to cause concerns. Residential construction will play an important role as Australia transitions to the next phase of its economic development after the mining construction boom.

Moderation to come

However it is clear that weaker employment conditions and ongoing household financial caution (evidenced by weak credit growth and elevated household savings) will likely lead to a moderating in house price growth in the future.

ANZ expects Australian house price growth will slow in the coming year to around 5 per cent in annual growth terms from 6 per cent year-on-year to June. We believe the RBA will tolerate this level of growth in order to ensure construction confidence picks up.

Clearly Australia is not completely immune from a housing market correction. What is clear, however, is that we do not face such a prospect in the foreseeable future.

As long as banks maintain their current level of caution we should avoid today’s modest uptick in housing market activity – which will underpin a turnaround in non-mining-related economic growth – from turning into a housing bubble.